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What are SPACs and should investors take notice?


 

Market Update

What are SPACs and should investors take notice?

 SPAC stands for Special Purpose Acquisition Company. It may have sounded unfamiliar until recently, but SPACs have been around for years. A SPAC involves an Initial Public Offering (IPO). But there’s a fundamental difference from a standard IPO which helps to speed up the process of going public. A SPAC is a company without existing commercial operations. It is formed simply to raise capital through an IPO for the purpose of acquiring an existing company. A rather neat description is that an IPO is a company looking for money, whereas a SPAC is money looking for a company.

How common are SPACs?

The acronym may have sounded unfamiliar until recently, but SPACs have been around for a long time and have become increasingly popular in recent years, raising $83 billion in 2020 — six times more than the previous year. Amazingly, that record has already been eclipsed in 2021. Data from SPACInsider calculates that by mid-March this year, 260 SPACs had already gone public, accounting for more than $84 billion in raised capital.

How do SPACs work?

The founders of a SPAC, or ‘blank cheque company’, may have an acquisition target in mind. However, not naming the target means they avoid extensive disclosures during the IPO process. Consequently, investors at the IPO stage have no idea what company they will be investing in. This means that a lot of the red tape is removed, making the process quicker and cheaper than a standard IPO. During the IPO, a SPAC sells shares with warrants that then trade separately, looking to use the funds to acquire a start-up or similar within 24 months. Once the acquisition is approved by investors, the SPAC merges with the target, typically changing its name to the start-up’s name and changing its ticker.

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What does this mean for investors?

SPACs often have sponsors associated with them, sometimes famous names from sports or show business. Typically, these sponsors get equity in the SPAC on more favourable terms than subsequent investors on the open market. So while a famous sponsor may raise interest and boost the attractiveness of the SPAC they’re associated with, it’s important to remember that they are getting compensated in ways unavailable to the retail investor. Original sponsors and other early investors such as hedge funds buy each share with a warrant in the SPAC for $10. Once the target is announced, shares in the SPAC may increase and give investors an opportunity to cash out for a profit. But if the news fails to make an impact and the shares drop below their initial $10 buying price, early investors can get their money back. They can also hold onto the associated warrant which gives them a risk-free investment with the potential of a high return. This isn’t the case for retail investors that bought the shares in the open market for more than $10. They can redeem them before the redemption date but will lose anything they paid over $10. Nor do they receive a warrant to go with their shares.

Are SPACs worth it?

In conclusion, for owners of smaller companies such as private equity funds, selling to a SPAC can be an attractive option. For a start, it can add up to 20% to the sale price compared to a typical private equity deal. Being acquired by a SPAC can also essentially offer business owners a faster IPO process under the guidance of an experienced partner, with less worry about swings in broader market sentiment. In addition, if the SPAC fails to complete an acquisition within two years, all funds are returned to investors. This is a great attraction as early investors will simply get their money back, so no risk. And this is really the key to SPACs: as an investor, you want to be able to get in early.

As for the retail investor, the advantages aren’t so obvious. The opportunities to buy into a SPAC generally come in the secondary market but remember they won’t get a warrant with their shares as early investors did. Then it’s all about the acquisition target and ultimately the price paid for it. If you’re a retail investor, you may get lucky, and shares could increase. But bear in mind that those at the beginning of the process have probably cashed in already and moved on to other money-making opportunities.

 


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